China’s Goldfinger

China has consistently been buying gold. But why?

Gold has recently hit an all-time high and finished last week at $2,360, but what has been driving the price higher?

It is a far cry from 1999, when Chancellor Gordon Brown announced his decision to sell half of the UK’s gold reserves when gold was standing at a 20-year low. That decision came to be known as the ‘Brown bottom.’ The total sale of 401 tonnes of gold bullion raised $3.5 billion, at an average sale value of $275 per ounce.

Gold tends to be driven by geo-political tensions, inflation, and interest rates. With US interest rates staying higher for longer, who has been buying gold? It looks as if central banks have been the buyers with Turkey, India, Kazakhstan, and some in Eastern Europe active, but specifically, The People’s Bank of China. According to the World Gold Council, China has increased its gold reserves by 16% over the last 17 months, successively taking its stockpile of gold to a record $170bn. China now has the sixth-largest gold reserves, just behind Russia. However, its holdings are dwarfed by the US which has the largest gold reserves in the world, worth over $600bn. Despite Gordon’ Brown’s poorly-timed disposals, the UK owns $32bn of gold.

The scale of China’s gold purchases at a time of record prices would suggest that this is a political project prioritised by the leadership in Beijing. Has President Xi Jinping become China’s Goldfinger?

China’s central bank began purchasing gold shortly after western sanctions froze Russian currency reserves held at foreign central banks in response to its invasion of Ukraine. Meanwhile, it has continued to sell-down its holdings of US government debt. There can be little doubt that the timing and the sustained nature of the gold purchases are all part of a lesson that China has drawn from the war in Ukraine.

China’s gold buying may also reflect the risk of long-term confrontation with the US in the Pacific and Xi Jinping’s ambition to reunify China with Taiwan. There is also the ongoing trade war with the US, ranging from technology to electric vehicles and rare earth minerals. With President Biden about to announce a fresh round of tariffs, the US presidential election adds further uncertainty, as Donald Trump has alluded to further punitive trade tariffs on Chinese goods, if he wins.

Markets remain hopeful that China will not resort to military force to reunify Taiwan, but will play the longer game, focusing instead on economic assimilation. However, the risk remains and US military officials have warned that China will have the capability to invade Taiwan by 2027. China is also throwing its weight around in the South China Seas, with several incidents with the Philippine coastguard and fishing vessels. Ominously, besides building China’s gold reserves, President Xi Jinping has campaigned for China to be self-sustaining in agriculture, which does beg the question, why?

What have we been watching?

UK equities continued to bask in the warm spring sunshine, with the FTSE 100 extending its run to hit another record close. This comes at a key time for UK plc, with some companies considering transferring their listings to the US and an increasing number of takeovers. London Stock Exchange prospects appear to be improving with reports suggesting that Singapore-based fast-fashion giant Shein is looking to list in London. Meanwhile, global equities continued to adjust to the prospect of ‘higher for longer’ US interest rates. However, US equities recorded the third successive week of gains. The 10-year US Treasury yield dipped below 4.5%, compared with a recent high of 4.75%. In Europe, the pendulum looks to have swung firmly in the direction of interest rate cuts. Switzerland’s central bank was the first to cut interest rates and has now been followed by Sweden which cut rates by 0.25%. A more dovish tone from the Bank of England has left markets expecting that a June interest rate cut is now more likely than not, with the likelihood of a cut at 62%. Sterling remained below $1.25, which is supportive of many UK exporters and overseas earners.

While truce talks between Israel and Hamas continue, tensions between Israel and its allies are rising as the IDF looks to be launching its ground offensive into Rafah. The US has paused the supply of large bombs to Israel, concerned by the damage these could inflict on dense urban areas of Gaza. Meanwhile, Iran has shown itself open to direct access talks with America, appearing to be ready for a change of course in its policy toward its arch-enemy.

The EU has agreed in principle to use windfall profits of about €3bn a year from frozen Russian assets to finance arms supplies to Ukraine. Meanwhile, Russia looks to be stepping up attacks on Ukraine’s energy grid.

The ongoing technology/trade war between the US and China has continued to escalate. The US have revoked licences that has allowed Intel and Qualcomm to ship semiconductor chips to Chinese telecoms equipment maker Huawei Technologies. Over the weekend US media reported that President Joe Biden is set to quadruple the tariffs on Chinese electric vehicles.

The Bank of England (BoE) left interest rates unchanged at 5.25% as expected, but the committee saw a shift with two votes for a 0.25% cut and 7 votes to hold. BoE governor Andrew Bailey did offer some encouragement by saying he was ‘optimistic that things are moving in the right direction.’ He would not be drawn to the prospect of a rate cut as soon as June, saying ‘it was neither ruled out or planned’ and suggested ‘more economic data will build confidence inflation is on track to hit target.’ Encouragingly, the BoE nudged its UK economic growth forecast for 2024 up from 0.25% to 0.5%, while 2025 was raised to 1% and 2026 to 1.25%. Inflation is expected to hit target in the second quarter of this year, averaging 2.5% for 2024. Meanwhile, the UK economy posted stronger than expected growth in the first quarter of 0.6%, exiting the technical recession at the end of 2023.

The European Central Bank is still expected to cut interest rates at its next meeting on 6^th June.

A reminder of the risk from the looming US presidential election was highlighted by credit ratings agency Fitch. It warned that the risk of a renewed US-led trade global trade war in 2025 is increasing, with Donald Trump flagging possible tariffs on Chinese goods of up to 60% and an across-the-board 10% tariff on all US imports. Fitch estimate this could knock between 0.4%-0.8% off US economic growth, but that this could increase to 1.1% if America’s trading partners retaliate with tariffs. Two of America’s biggest trading partners, China and Mexico would be most affected with by a hit to economic growth of 1.8%.

The Bank of Japan published the minutes of its last meeting, which showed that it is prepared to raise interest rates if the weak Yen leads to price increases, stoking inflation.

Chinese exports recovered in April with growth of 1.5%, which was better than expected. Meanwhile, imports were also stronger than expected, growing by 8.4%.

Brent oil hovered dropped back to under $83.

Finally, remember QE- Quantitative Easing? Well, the BoE has updated its estimates for the overall likely QE losses that may crystalise over the next 10 years. Assuming it sells £100bn of gilts per year and holds the others to maturity, then based on the current expected path of interest rates, the net loss would be £85bn by 2034. Ah, the crazy days of QE, when German bund yields turned negative! The 10-year German bond yield is now about 2.6%. Ouch!

Read Last Week’s Alpha Bites – China has that sinking feeling

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China’s Goldfinger

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